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Belated hike of consumption tax and its implications

Ⅰ.  Introduction

   Following the declaration of prime minister Shinzo Abe in October 2018 to increase the consumption tax from the ongoing rate to 8% up to 10% at the beginning of October 2019, the necessary budget to accommodate this tax increase has been written in the annual budget plan for FY2019 which was disclosed at the end of 2018. With these steps, the consumption tax hike which would have been realized much earlier finally will be executed in October 2019.

  In this essay, I will review the prolonged process to prepare and execute the increase of consumption tax from 8% t0 10%,  the current policy package to execute the consumption tax increase and discuss its implications.

 
Ⅱ.  Review of the process of consumption tax hikes

   Consumption tax increase has been a major home work left for Abe administration from the preceding two Democratic Party administrations led by prime minister Naoto Kan and prime minister Yoshihiko Noda. 

    At a G7 conference of finance ministers held in Canada in 2010, the then minister of finance Mr. Yoshihiko Noda of Naoto Kan cabinet made an international commitment that Japan will increase consumption tax from then 5% up to 10%. This was the response of Japanese government to the international community of fiscal policy who were deeplyconcerned about Japan’s excessive accumulation of government debt in a way to show the determination to enhance fiscal discipline of Japanese government. Mr. Noda’s commitment also had an implication to alter the compositional balance of direct and indirect taxes by way of increasing the proportion of tax revenue of consumption tax vis-a-vis income tax in the increasingly aging society of Japan.

   In that year, Kan administration also set forth the fiscal consolidation plan in which the government plans to reduce fiscal debt from 2010 and attain zero of the primary balance by 2020. To achieve the goal of the plan, appropriate increases of consumption tax has been regarded imperative.

   To pursue that goal, three party agreement has been attained in 2012 by Democratic Party of Japan, Liberal Democratic Party and Komei Party in which they agreed to increase consumption tax rate from 5% to 8% in April 2014 and 8% to 10% in October 2015.  In December, Mr.Shinzo Abe took the office of prime minister and Abe administration stared. Abe administration naturally was supposed to attain the plan of
3 party agreement. In other words, increases of consumption tax have become the home
work for Abe administration.

   Abe administration executed the committed increase of consumption tax rate from
5 to 8% at the beginning of April 2014. Since 3%point increase was a major increase,
consumpers reacted dramatically as expected. Prior to the tax increase, they rushed to
buy goods and services which increased the GDP of first quarter of 2014 as much as
4.9% at annual rate, and then the trend was reversed after the tax hike. Consumption shrunk sharply in the second quarter of 2014 as much as minus 7.1% of GDP annual rate.

   Consumption has remained quite weak for a long time since then and the economy seems
to have lost its viability. This phenomenon of a negative effect of tax hike on consumption  apparently has become the serious concern of Abe administration. While the increase of
consumption tax was regarded as an important step toward the comprehensive reform of
tax and social security, only one percent worth of the increased revenue has been used for social security, the basic aim of enriching and fortifying social security has barely been satisfied.

   Prime minister Shinzo Abe grew increasingly nervous about the effect of tax increase
on economic performance. He ordered ministry of finance to coin a good idea to mitigate
the impact of tax increase on consumers, particularly of low income consumers. Ministry
of finance proposed an idea of partial refunding to lower income people utilizing the tax
payer identification number system which was to be introduced. However, this requires
low income consumers to prepare necessary documents to ask for refunding. Warring
about cumbersome burden on such consumers, Komei party strongly opposed against
the idea of ministry of finance.

    Komei Party instead strongly proposed to introduce reduced tax rate for necessity items such as food. This reflects their notion that low tax rate for foods is helpful for low income
people who the party regards their critical supporters. This idea has been reportedly pushed
forward strongly by female segment of the party which often has an important influence on the party decisions. The reduced tax rate of food in effect has a regressive impact since
the wealthier people spend much more money on food. In the political process, however,
the strong recommendation of Komei party’s reduced tax rate was adopted as a political compromise even in spite of critical advices of tax policy specialists. This debate ended
up with introduction of reduced tax rate for foods for prospective tax increase for 10% in the form of LDP and Komei party agreement.

   Prime minister Abe stated that he will decide the next tax hike in November 2014.
Many experts such as Ministry of finance officers,  economists including IMF specialists
argue that consumption tax should be increased to 10% as soon as possible on the ground
that economic performance is good, there is no guarantee that the economy will be better later and no important election is scheduled.

   However, on November 18, 2014, prime minister Shinzo Abe declared that he will postpone the timing of increasing consumption tax rate to 10% for a year and a half to
April 2017. He also announced to call for a general election to ask the view of the people
because he changed the public promise of the date of consumption tax increase and declared to resolve the House of Representatives on Nov.11 and set the voting date
on December 14.  The result of the election was a land slide victory of LDP and Komei
party.

   In spring of 2016, prime minister Shinzo Abe began preparing theoretical reasons to
possibly postponing the timing of increasing consumption tax rate further including inviting
eminent economists such as professors James Stiglitz and Paul Krugman. Having listened to their views Mr.Abe told that he learned that the world economy entails downward risks,
monetary means have limits to counter such risks, fiscal spending is necessary, therefore
there remains little room for an economy like Japan to raise taxes.

   On June 2, 2016, prime minister Abe announced to postpone once again the timing of increasing consumption tax rate to 10% to October 2019. He said it is necessary to prepare for countering probable global downward risks. In July 2016, prime minister Shinzo Abe hosted G7 summit at Ise-shima national park in Mie prefecture. He urged to the leaders of
the world the necessity of fiscal stimulus which many leaders did not quite appreciate. Mr.
Abe said that if the world economy suffer from a major shock such as the Lehman’s class,
the timing of increasing consumption tax will be postponed further. While many national
leaders and experts did not really listened to Mr. Abe’s warning, he is lucky enough that
a major shock hit the global economy after June 23, namely, British national referendum
for “Brexit,” which exerted at the moment even the larger downward shock to stock market
than the time of the Lehman shock.


 
Ⅲ.  Policy package to increase the rate of consumption tax

     In October 2018, a year prior to the planned timing of consumption tax increase,prime minister Abe reportedly made up his mind to execute the planned increase of consumption tax rate from the ongoing 8% to 10%. He has also been ordering the relevant government offices to prepare policy package to mitigate the likely negative impact on consumption due to the increase of consumption tax rate.

   In the evening of October 15, prime minister Abe declared at the extra-ordinary Cabinet
meeting that he will execute the increase of consumption tax rate up to 10% as planned.
And now openly assigned all relevant ministers to prepare economic policy package
to prevent negative reactions after the tax hike.

   The issue of introducing reduced tax rate for foods gives rise to many problems at
the shops as well as the ministry of finance. For small businesses dealing with dual tax rates, the government has been advocating to equip themselves with necessary cashing machines and relevant ordering and receiving facilities.

   The ministry of finance is faced with the problem of how to secure budget to make up for the reduced tax revenue due to reduced tax rate for foods.  The forgone revenue is estimated as much as 1 trillion yen. The ministry plans to carve out 700 billion yen from
increasing tobacco taxes etc, and the rest of 300 billion yen from hopefully increased
revenue from small businesses, who have been exempted from reporting of consumption tax revenue, now begin to report consumption tax revenues in order to secure business
with large firms after introducing “invoice” system.

   The exempted small businesses are about 5 millions. Since they are exempted, they are
unable to issue invoice. Since large firms cannot write off consumption tax spending in transacting with exempted small businesses who cannot issue invoice, they tend not to
have business with such exempted small businesses. However, once the invoice system is
widely introduced, some of these small businesses will shift to non-exempt businesses in order to secure business transactions with large businesses. Ministry of finance expect that
the shift of such small businesses will increase tax revenue as much as 300 billion yen.

   In early November, Komei party presented a policy proposal to mitigate the negative impact of consumption, particularly of low income consumers.Their proposal includes:
 (1) implementing reduced tax rate system surely, (2) providing gift certificates to reduce the
burden of households, (3) tax reduction for those who buy houses and cars after the tax hike, etc. While Komei party apparently had a strong influence in preparing economic
policies to mitigate the likely negative effects of tax hike, there remained some skepticism among LDP members about the effects of Komei proposals.

   On November 23, prime minister Shinzo Abe talked about 5% refund for the consumers who bought things without using cash, the idea which has been developed and included
as one of the important items of the final policy package. In the process of preparing the consumption tax related policy package, reduction of taxes of purchasing cars was also
included as an important item.

   On December 22, 2018, the budget plan for FY2019 has been disclosed. The necessary
budget to execute consumption tax hike has been included thereby the increase of consumption tax rate has been formalized.
   The total fiscal budget for FY2019 is 101.4564 trillion yen. In which policy package to
mitigate the possible negative effects is accounted for 2.0280 trillion yen.

    The expected increase of tax revenue arising from 2% point increase(8% to 10%) of consumption tax rate is 5.7 trillion yen, which tax payers are supposed to pay if nothing else has done. In reality, 1 trillion yen is subtracted in the form of reduced tax for foods.
Also, 1.5 trillion yen is substantively subtracted in the form of tree education for very young
and higher education students. After such subtractions, the net burden on tax payers due to
2%p increase of consumption tax rate is 3.2 trillion yen.

   On the other hand, the government stipulates as policy package to mitigate possible or likely negative effects of consumption due to tax hike the following items. They include:
 (1) Refunding for cashless purchases, for 9 months from Oct.2019 till June 2020.
     Refund rate is 5% for small shops and 2% for shops of large chain store networks
(2)  Gift certificates for low income families and infant raising families.
      Up to 25000 yen worth certificate for 20000 yen purchase.
(3)  Housing subsidy, for relatively lower income households, up to 0.5 million yen
(4)   Subsidy for next generation housing such as energy conservation houses.
(5)   Houses imposed 10% consumption tax, income tax deduction eligible period extended
       from 10 to 13 years.
(6)   Reduction of car taxes, cars bought after October 2019, yearly up to 4500yen reduced
(7)   Reduced tax rate for foods for all consumers.

The policy package to mitigate possible negative impacts of the tax hike altogether will amount to 2 trillion yen. Adding tax reductions for house and car purchases would total
approximately 2.3 million yen.

Interpreting this package as additional income for tax payers, the net burden of tax payers arising from the tax hike of October 2019 will be only 1 trillion yen.


Ⅳ.   Implications of this hike of consumption tax and evaluation

   Having learned about the prolonged process of increasing the rate of consumption tax
and the policy package planned by the government accompanying the tax increase, let us
consider their implications.

1.  The prolonged process of consumption tax increase.
    To raise the rate from 5 to 10%, it altogether will have taken 5 years and a half.
Prime minister Abe postponed twice the planned timing of tax increase from October
2015 till October 2019.

     The most pressing issue for Japanese economy, in my view, is the rapidly accumulating
government fiscal debt. Tax increase is an important measure to reduce or control the pace
of increase of the debt. During the four years elapsed by prime minister’s repeated postponing of tax increase, the total accumulated fiscal debt increased by the amount as much as 100 trillion yen. Although the forgone tax revenue during this period which would have been gained is some 20 trillion yen, this repeated postponement certainly aggravated the worsening of the fiscal debt situation for the country.

2. Effects of policy package accompanying the tax hike
   Abe government planned various policy measures to mitigate possible negative effect on consumption due to increase of tax rate. The package altogether amounts to 2 trillion yen.
If subsidies for houses and tax reduction for purchase of cars are added, the total amount would be some 2.3 trillion yen. The government also provides reduced tax rate for foods and free education for certain ages of children and youths which altogether amount to
2.5 trillion yen. These measures make the net increase of tax revenue only 0.8 trillion yen
out of the total of 5.6 trillion arising from 2 %point increase of consumption tax.
 
  Question is what can be done by only 0.8 trillion yen accrued from the precious increase
of consumption tax rate this time. The original purpose was to use the increased tax revenue for fiscal consolidation on the one hand, and enriching social security on the
other. With only 0.8 trillion yen, only very little can be done to pursue these goals.

   Another question is whether such measures would be really effective to increase consumption. Most of measures will certainly increase household income of consumers marginally but its effect of increasing consumption additionally is highly skeptical. Moreover, too much short term incentives provided by such measures may induce negative reactions when such incentives are terminated after a certain period.

3. Negative effect of tax increase and long term strategy to reconstruct the country
   Prime minister Shinzo Abe appears to be so fearful of possible negative effect on consumption by the tax rate increase. He may be preoccupied by the “trauma” of the negative reaction of consumption in the second quarter of 2014.

   But is this economic fluctuation such important to overlook the issue of structural
deterioration of fiscal balance of this country. The enormous accumulation of fiscal
debt for the size of economy may well lead to fiscal or economic collapse of the nation
if the economy is hit by serious shocks. For detailed explanation of this issue, see Haruo Shimada “Aging and Possible Fiscal Crisis: Are There Remedies? FPCJ Press Briefing in the afternoon of Oct. 3, 2018, contained my blog essays “Japan Topics

   One of the reasons why Japanese population is uncertain for the future and cannot be
confident to spend is their worry about the pessimistic notion of fiscal condition of the country. Although most people do not know much about details of the problem, many
of the population have a vague worry and uneasiness for the future of the country.

   It is my view that prime minister Shinzo Abe should have courage and determination to
talk to people the real picture of the fiscal situation of the country honestly, and seriously,
and ask their understanding and cooperation to raise taxes to reconstruct the fiscal health
of the country. The public of Japan must have ears to listen to such serious talk of the leader of the country and particularly his positive view to reconstruct the country for the
future. For my policy recommendation for a long range plan to transform Japan, see Haruo Shimada “Aging and Possible Fiscal Crisis: Are There Remedies? FPCJ Press Briefing in the afternoon of Oct. 3, 2018, contained my blog essays “Japan Topics

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